|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||2,050||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT|
Sign up for free guest access to view investment idea with a 45 days delay.
Adesa Inc. (KAR) is a key auction provider for the used and salvage vehicle industry (“vehicle remarketing”) as well as a provider of floor plan financing for independent used car dealers. The company was spun off from the utility Allete in June 2004. Both the used and salvage markets are oligopolies; KAR is #2 in used and #3 in salvage.
Current pessimism regarding the state of supply and demand in the used car auction market and a disappointing Q2 is creating the opportunity to buy the stock with 30%-60% appreciation potential aided by several catalysts:
¾ Earnings growth of around 10% for the next several years
¾ EBITDA margin expansion potential of 200-300 basis points due to previously-spent capex on process improvements
¾ Secular increases in the volume of used vehicles presented at auction to be sold (which would also improve operating leverage and expand operating margin further).
¾ Potential stock buybacks from prodigious excess free cash flow
Today, the business trades at 10.5 of LTM EV/EBITDA-Capex (9X using maintenance capex). By 2008, I expect EBITDA to reach $330MM with maintenance capex in the $40MM range while producing over $100mm of free cash flow per year in the intervening time. Using EBITDA-Capex multiples ranging from 9X to 11X and expected zero net debt versus slightly over $200MM today, creates a price target range of $29 to $35 per share versus a price of around $22 today.
Description of Business
Adesa auctions over 1.9MM vehicles a year, 90% of which are used as opposed to salvage, via 54 used vehicle auction sites and 31 salvage sites (both use the internet for incremental sales as well). In total the company receives about $425-$450 per transaction on a blended basis which is comprised of approximately $275 of fees (a closely guarded number) and the rest in services. Pricing power has been fairly robust over the last 5 years with fees growing by approximately 5% per annum. This business has 25%+ EBITDA margins and decent operating leverage as additional auctions or incremental sales do not add heavily to operating expense. The company does not take inventory risk, the sales are considered wholesale consignments. The auction side of the business should do close to $925MM in sales in ‘06 (88% of revenue and 75% of consolidated EBITDA).
The floor plan finance business (“AFC”) operates out of 85 branches (52 of which are on the site of auctions). The business should do $125MM in finance revenues this year and ~$88MM in EBITDA (~13% of total revenue ~28% of EBITDA). These loans are short term in nature (30-45 days) and made mostly to independent car dealers. The loans are Prime Rate based plus a spread and generate fees as well ($75-$110 per loan). Over 13,000 dealers have available credit of which 8,500 have outstanding balances. The average line of credit is $122k with the average value per vehicle of $7,300. This business is financed via a structured finance conduit. At
Given only 11% of the company’s auction volume is salvage, I will focus on the used auction market. The North American vehicle population stands at 258MM—known as Vehicles in Operation (VIO). Apart from VIO growing roughly with inflation, 19MM new vehicles join VOI per year and 12MM are scrapped each year causing a yearly net increase. Approximately 1 in 5 used cars change hands a year. This creates about 46MM of used vehicle transactions per year. Auctions account for 10MM, 14MM are consumer to consumer, wholesalers account for 7MM and dealer trades account for 15MM units. Management believes there is opportunity to steal share from the other used sales categories beyond competing auctions.
Vehicles come to auction via Institutional sellers (lessors selling off-lease cars, fleet providers and rental car providers turning over their fleet) and Wholesalers (dealers and traders who buy cars and sell to retailers who in turn sell to a consumer). At auction, the supply is split evenly between the two parties. In the case of KAR, they are more overweight Institutional (60/40 percent).
Manheim Auctions is the 800 pound gorilla in the used space with 51% market share and is owned by Cox Communications. Adesa is #2 with 18% market share. Independents make up the remaining 31% with the next largest in the mid-single digits. The auction business is one of scale because liquidity is paramount so the industry is consolidating more with each year. The total industry revenue is estimated to be $4B+ (the average ticket is over $400/vehicle).
The salvage auction market is smaller by volume versus the used auction business—about 1/3 the size. The auctions keep about 25% of the total gross due to the related services and additional value added. The total revenue is estimated at $750MM. Copart has 35-40% market share, IAAI has 25% followed up by Adesa at 8%+ (a recent acquisition has increased their share slightly). Similar to the used auction, around 30% of the market is independent.
Fully Diluted Shares Outstanding: 90.1 MM
Recent Price: $22.79
Market Cap: $2,053 MM
Net Debt: $207
EV: $2,260 MM
Why Adesa is Currently Cheap
From a macro perspective, as VIO grows and scrapage rates decline (creating net growth in VIO of 7MM vehicles per year), vehicles have to clear the market eventually at some price. Because this is an auction, price (at which the vehicle sells, not the auction fees) has to adjust when supply grows. Many industry analysts with longer term perspectives believe that conversion rates will increase when prices decline which will increase auction sales. As one industry player said, “demand is always there if the price is right and it eventually has to happen.” This point is important to the thesis: vehicles continue to depreciate and wholesalers are wasting money every day a vehicle is not sold (additionally, these vehicles are usually financed), so there is an incentive to sell ultimately at some eventual price. Adesa will get its share of auction sales as pent up supply clears the market.
Secular shifts in the “institutional” vehicle auction supply due to increases from rebounding lease and fleet vehicle programs will lift wholesale auctions, and Adesa in particular, in the coming quarters. In addition, company initiatives to expand key markets, improve processes with technology and create a more cross selling opportunities between the auction, salvage and finance units should provide additional organic growth and margin improvement in the next few years. The combination of all of the above factors should lead to both multiple expansion and increasing earnings of at least 10% over the next couple of years.
The opportunity for growth comes from several avenues:
A brief look at the 10k shows 26 sites with 9 lanes or less in the
Fleet and Rental Car usage, a major source of used auction supply declined heavily after 9/11 and has since rebounded. Fleet and Rental sales bottomed out in 2003-2004 at 2.54MM vehicles and have since rebounded to over 3MM vehicles in 2005. These cars generally go to auction 18 months later which will aid in the expected increase in vehicles coming to auction in 2007 and beyond.
A combination of increased supply from improved off-lease and fleet supply, Adesa’s push to increase supply from dealer consignments and the moderation of used car wholesale prices will create normalized conversion rates of around 62% or better and mid-single digit revenue growth. This should conservatively create EBITDA of at least $330MM with maintenance capex of around $40MM or EBITDA-CAPEX of $290MM by 2008. Given its stable industry, high free cash flow and profitability would at least garner a 10X EBITDA-capex multiple. Assuming $200MM of incremental free cash flow by 2008 would create no net debt and a price target of $32 per share.
Buyout firm Kelso and Company’s acquisition of salvage auction IAAI in 2005 for 10.1X LTM EBITDA which translates to a share price of $29 using 2006 Expected EBITDA of $280MM ($37 per share using ’08 estimates). Similarly, Allete originally paid 9.5X EBITDA in 1996 for a much smaller Adesa (475k vehicles sold at their auctions in 1996 versus 1.9MM in 2005).
|show sort by|
Are you sure you want to close this position ADESA INC.?
By closing position, I’m notifying VIC Members that at today’s market price, I no longer am recommending this position.
Are you sure you want to Flag this idea ADESA INC. for removal?
Flagging an idea indicates that the idea does not meet the standards of the club and you believe it should be removed from the site. Once a threshold has been reached the idea will be removed.
You currently do not have message posting privilages, there are 1 way you can get the privilage.
Apply for or reactivate your full membership
You can apply for full membership by submitting an investment idea of your own. Or if you are in reactivation status, you need to reactivate your full membership.
What is wrong with message, "".